Giga Factories And Patent Giveaways: Musk's Tesla Moat Building Strategy

Jun.29.14 | About: Tesla Motors (TSLA)

Summary

Elon Musk is trying to build a wide and effective moat around Tesla.

The Giga Factory and the open sourced Tesla patents are at the root of Musk's moat building strategy.

Musk's strategy could change Tesla's business focus from cars to batteries.

Tesla has some interesting similarities to Amazon.com.

Is Elon Musk a crazy, risk-taking visionary driven by idealism or a hard-headed businessman pursuing a value-building strategy that would make Warren Buffett proud? Judging by his latest moves at Tesla Motors (NASDAQ:TSLA), it's harder to tell than you might think.

Musk has made two major changes in Tesla's strategy in recent months that have attracted a lot of media attention: the Gigafactory and his announcement that Tesla's patents are now open sourced. These moves seem visionary, but they are also a clear effort to build a moat around Tesla.

Musk Likes Moats

A moat is a set of advantages that make the cost of competing directly with a company prohibitive. The term comes from Warren Buffett, who compares such advantages to the moats around medieval castles that were designed to make it too difficult to besiege the fortresses.

Judging by his other ventures, Musk is an entrepreneur who likes moats. Observers such as the Guardian's Joe Pappalardo have noted that Musk's rocket company, Space X, offers launch services that cost about one fifth those of competitors. That gives privately held Space X a pretty neat little moat. Musk also created PayPal, which now gives eBay Inc. (NASDAQ:EBAY) a very nice moat.

Ideally, a moat should pay for itself or at least add to the company's revenues as well as protect the company. PayPal now generates around 43% of eBay's revenues.

Musk's Moat Building Strategy for Tesla

Musk has devised a rather clever, two-pronged moat building strategy for Tesla. The strategy is based on the Giga Factory and the open sourced patents.

The Giga Factory is intended to be a giant manufacturing facility for lithium ion batteries that would be located somewhere in the western United States. The idea is to churn out enough batteries each year to store 35 gigawatt hours of electricity or power 500,000 electric cars by 2020. The factory would also revolutionize battery production by making the batteries from scratch.

Musk has also made Tesla's patents open sourced, or in the public domain, by announcing he will not sue other automakers that infringe upon them. In other words, he basically plans to give the patents away.

This strategy could give Tesla a moat by providing the company with a 30% cost advantage. Musk thinks the Giga Factory could also help Tesla produce a mass-market electric car with twice the range of the Nissan Leaf or the Chevy Volt and faster acceleration.

The open sourced patents could give Tesla more revenue by creating a larger market for the Giga Factory's lithium ion batteries. Musk is hoping that other automakers that adapt his technology will buy batteries from the Giga Factory.

Tesla obviously isn't going to have the capacity to produce 500,000 cars a year any time soon. Musk is planning to sell batteries to other automakers, which is a pretty audacious plan. He's hoping to turn competitors such as Toyota (NYSE:TM) and Ford (NYSE:F) into customers.

Nor are automakers the only potential customers; there are lots of potential uses for those lithium ion batteries. Tesla's patents could be adapted for a wide variety of electric vehicles, including buses, delivery trucks, tractors, earth moving machines, and forklifts. The batteries could also be used in lawn mowers, in tools, and as backups for solar electric systems like those sold by Musk's other publicly traded company Solar City (NASDAQ:SCTY). Another potential market is data centers which use vast amounts of electricity.

There are probably lots of other industrial and commercial uses for those batteries I haven't even thought of here. The Giga Factory could actually take Tesla out of the car business and into the battery business. That would give Tesla something it sorely needs-revenue and cash flow-as well as a moat.

Tesla Needs Revenue

Tesla is one company sorely in need of revenue. The company reported a net income of -$135.06 million on March 31, 2014. In contrast, Toyota Motor reported a net income of $18.24 billion on the same day.

The strategy is to build revenue and a moat at the same time while laying out the groundwork for a new industry and borrowing to finance it. News reports indicate that the Giga Factory could cost between $4 and $5 billion, much of which will be covered by issuing convertible senior notes.

That strategy reminds me of another over-the-top, visionary industry builder: Jeff Bezos; Bezos has done much the same thing building up Amazon.com (NASDAQ:AMZN). It is no mistake that ycharts.com uses Amazon.com as a benchmark for Tesla.

Just like Jeff Bezos, Elon Musk is trying build a massive new kind of company with a gigantic moat around it. The plan is audacious and entertaining. Like Amazon.com, Tesla isn't necessarily a great investment, but it's sure a fun company to watch.

Disclosure: The author is long EBAY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I conduct online retail sales through Amazon.com and eBay